Bad Regulation: Basel 2.5 and Basel 3

Abstract

On 1 January 2012, a “milestone” of international financial regulation was passed when a precursor to Basel 3, Basel 2.5, presumably came into force. While the development of Basel 2.5 (and Basel 3) is the product of the realisation that Basel 2 could not have dealt adequately with the global financial crisis, nothing much has changed in the sense that most of the criticism of Basel 2 can be directed at Basel 2.5. It is a complex and tedious set of capital-based regulations that overlook critical issues such as leverage, liquidity, the separation of investment and commercial banking, and the problem of TBTF. The treatment of leverage and liquidity was left for Basel 3, which is scheduled to be implemented in 2019, as if these were trivial matters that can wait. Worst of all is that Basel 2.5 maintains the procedure whereby regulatory capital is calculated on the basis of risk-weighted assets, where weights are determined primarily by the credit rating agencies.